The year-over-year decline is the first since January and considerably more than economists had expected. The 1.3% drop from September marks a third consecutive decline.

In another sign of economic weakness, consumer confidence dropped unexpectedly in December. The Conference Board's consumer confidence index, which had improved in November, fell slightly in December to 52.5 from 54.3.

The present-situation index — which measures how people feel about their current economic circumstances — declined to 23.5 from 25.4. The expectations index — which measures how people feel about their future prospects — fell to 71.9 from 73.6 last month.

"Consumers are still in a fragile state and confidence remains at depressed levels despite strong holiday retail sales, low prices and a relatively robust stock market," said Chris Christopher, an economist with research firm IHS Global Insight. "The poor housing market performance, high gasoline prices and a lackluster job market are keeping consumers in a tepid mood."

The index is based on the Conference Board's survey of 5,000 U.S. households. The group started the survey in 1967. The index is benchmarked to consumer sentiment in 1985, because that year was neither a peak nor a trough. Any reading above 100 indicates strong growth.

Forecasters in recent months have turned upbeat on the prospects for the U.S. economy, predicting strong growth that could add jobs in significant numbers and eat into the stubbornly high unemployment rate. But Zandi of Moody's Economy.com said the foreclosure crisis remained the biggest threat to that recovery.

"I believe we are going to get strong economic growth in 2011, and enough job growth to bring down unemployment, but the ongoing foreclosure crisis and the prospect of more price declines is the great threat to that optimism," he said.

"As long as house prices are weak, the economy just can't get into full swing. The home is still the most important asset that most households own, and if it is falling in value they are far less willing and able to spend."